Business Planning

S Corp vs C Corp: What Are the Differences & Which Is Best for You?

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When incorporating your business, it’s important to consider C corp vs S corp when choosing your business structure. Choosing the wrong structure may cost you time, money, and unnecessary stress. In terms of incorporation, there are two types of business structures available:

  • S Corporation (“S corp”)
  • C Corporation (“C corp”)

Both have advantages and disadvantages. Below explores these two types of corporations to help you make informed decisions in regards to the incorporation of your business.

What is an S Corp?

An S corporation is a type of corporation that passes income, losses, deductions, and credits to shareholders. Such passing is executed so as to avoid double taxation of corporate income.

The phrase “S corporation” refers to Subchapter S of the Internal Revenue Code [1] IRS.Gov. “S Corporations“. Accessed January 12, 2022.. When a business entity selects Subchapter S of the Internal Revenue Code as their tax status, they then become an S corp.

A business must meet certain legal requirements to receive an S corporation status. These requirements are:

  • Incorporation within the United States
  • Offer no more than one class of stock
  • Have 100 or fewer shareholders total
  • All shareholders meet outlined eligibility requirements by IRS

Shareholders for an S corporation must be individuals, specific trusts and estates, or some tax-exempt organizations (i.e. 501 (c)(3)). Shareholders that don’t qualify as eligible shareholders are partnerships, corporations, and nonresident aliens.

Advantages of an S corp

An S corporation offers benefits that are more favorable to certain small businesses. The single biggest advantage an S corporation offers that a C corporation does not is a single layer of taxation. S corporations do not pay corporate-level income taxes, as the distribution of income is the responsibility of the shareholder. This individual-level taxation allows the corporation to take advantage of the same benefits as a partnership.

individual income tax return varying based on s corp vs c corp

Another advantage comes from the Tax Cuts and Jobs Act of 2017 [2] Congress.Gov. “H.R.1 – An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018“. Accessed January 12, 2022. , granting eligible S corporation shareholders a deduction of up to 20% of net qualified business income.

Losses that an S corporation incurs are also passed through to its shareholders. In doing so, they may leverage those losses to offset income. However, there are some restrictions to this pass-through of losses.

Disadvantages of an S corp

S corporation status isn’t always the most beneficial for all small businesses. For starters, you can’t have more than 100 shareholders under this tax status. This limits your ability to raise working capital from new investors. It also prevents your business from going public.

S corporation examples

Let’s say that you and four shareholders start an eCommerce business. In its first year, the company makes $1 million in revenue. The income drawn from that revenue depends on the percentage of shares each shareholder owns. If each shareholder owns 20 percent, it is equal to $200,000. The company itself doesn’t report this income to the IRS. Instead, each shareholder reports this income in their individual tax returns.

How to register as an S corporation

You can register your business as an S corporation by submitting Form 2553 [3] IRS.Gov. “About Form 2553, Election by a Small Business Corporation“. Accessed January 22, 2022.. All shareholders must sign the document.

It’s important to review the instructions for Form 2553 [4] IRS.Gov. “Instruction for Form 2553“. Accessed January 12, 2022. . It includes all the required information, as well as how to determine where to file the form.

What Is a C Corp?

A C corporation is subject to taxation of owners or shareholders separate from the corporation. This creates a situation of double taxation, as the corporation and shareholders are taxed for income.

A business set up as a C corporation limits the investors’ responsibility for business liabilities. The most that investors may lose if the business fails is their own investment.

A C corporation is its own entity. It may own its own property, pursue and enter into contracts, sue (or vice versa), and lend or invest money. C corporations must hold annual meetings and have a board of directors. Who sits on the board of directors is voted on by the shareholders.

Advantages of a C corp

office employees looking computer screen stock options for c corp vs s corp

Becoming a C corporation offers considerable benefits. For instance, there’s no limit on how many shareholders you can have. There are also no restrictions on share ownership, as business entities and non-U.S. citizens may hold shares. Additionally, there aren’t restrictions on stock classes for C corporations. More than one stock class can be issued. This includes dividends, distributions, and stock with preferences. With fewer restrictions, it’s generally easier to raise working capital under a C corporation status.

The Tax Cut and Jobs Act of 2017 lowered the maximum tax rate for C corporations to a flat 21 percent.

Disadvantages of a C corp

The greatest disadvantage of having a C corporation is double taxation. The shareholders must pay taxes on dividends and the corporation must pay taxes on its earning.

C corporations are also much more complex in terms of state and federal tax requirements. To be compliant, you will likely need to enlist a lawyer and an accountant if you have not yet done so.

C corporation examples

Rapidly growing businesses, especially those on their way to becoming household names, would likely benefit from a C corporation status. Businesses like McDonald’s, Starbucks, and Apple are C corps.

How to register as a C corporation

To achieve C corporation status, you must file the Articles of Incorporation, sometimes called a Certificate of Incorporation. You submit this document to the state in which you’re doing business. Each state has filing fees that you’re responsible for paying.

Once the Articles of Incorporation filing process is complete, there are other requirements to fulfill. These include:

  • Adopting bylaws
  • Holding an initial meeting with shareholders and directors
  • Issuing stock to owners

Which Structure Is Best for Your Business?

Choosing between an S corp vs C corp is an important decision.

Some reasons you may want to choose the S corp status for your business are:

  • Limiting shareholders
  • No interested in wide expansions
  • Desire to avoid double taxation

Meanwhile, some reasons you may want to choose the C corp status for your business are:

  • Plans for wide expansion
  • Comfort with taxes at the corporate and individual levels
  • Desire for your business to be acquired in the future

Differences Between an S Corp and a C Corp

With a good understanding of how an S corporation and a C corporation differ, it’s easier to decide which to choose. That said, below explores the ways that an S corporation and a C corporation are different from one another.

Formation and business structure

Both S corps and C corps begin as C corporations. To form an S corporation, the business files IRS Form 2553. There may be additional state forms to file regarding state taxes.

Taxes

The biggest difference between an S corporation and a C corporation is how they’re taxed.

Federal tax regulations require C corporations to report profits on corporation tax returns. These profits are taxed on the corporate tax return, as well as the individual shareholders’ tax returns.

Meanwhile, S corporations pass taxes from the company to its shareholders. Therefore, the profits aren’t taxed on the corporate tax return. Profits are only taxed on individual shareholders’ tax returns.

Corporate ownership

The C corporation status allows for more flexibility in regards to stocks. An S corporation must follow these requirements:

  • No more than 100 shareholders
  • Only one class of stock issued
  • Only U.S. citizens are shareholders
  • No shares owned by another C corporation, S corporation, LLC, partnership, or trusts

C corporation status does not impose such restrictions.

Benefits

Many companies provide benefits to shareholders who are employees. If at least 70 percent of the employees of a C corporation receive the benefits, they aren’t taxed. C corporations may also deduct charitable donations.

As stated above, S corporations are unique in that their tax burden is passed through to the individual shareholders to avoid double taxation. Additionally, S corporation owners can claim the qualified business income deduction in which 20 percent of the business’ net revenue may be deducted to reduce the overall individual tax burden.

Similarities Between an S Corp and a C Corp

office professionals in industrial office of c corporation

While it may be easy to distinguish S corporations and C corporations by their many differences, the two do have many similar characteristics. Below are a few ways these business structures are similar.

Limited liability protection

With both structures, shareholders aren’t responsible for the business debts or financial obligations. If the company goes under, shareholders aren’t responsible to pay for debt or other financial obligations the company may have.

In both an S corporation and a C corporation, there’s the option of the company and the owner acting as separate legal entities. Such separation ensures separate liability. Corporations offer owners the strongest protection against personal liability.

Filing documents

For an S corporation and a C corporation, you must file articles of incorporation. While these articles are similar for both structures, an S corporation has more document requirements.

Structure

An S corporation and a C corporation are structured similarly in that both entities issue stock. Shareholders own said stock. They also adopt bylaws, file annual reports, elect a board of directors. The shareholders elect the board of directors.

In regards to this subject, the major difference, as stated above, is an S corp has restrictions on corporate ownership to which a C corp doesn’t have to adhere.

Corporate formalities

In both S corps and C corps, the CEO manages the business and the team. Meanwhile, policy and management issues are the purview of the board of directors.

S Corp vs C Corp: The Bottom Line

The decision between a C corp vs S corp will impact your business in the short term, with annual tax filings and options for business funding, as well as the long term in regards to growth opportunities. To choose the best incorporation option for your business, you’ll have to envision your business today and what you hope your business will look like tomorrow. Once you’ve gone through the pros and cons of an S corporation vs C corporation, you’re ready to start accepting payments.

Article Sources

  1. IRS.Gov. “S Corporations“. Accessed January 12, 2022.
  2. Congress.Gov. “H.R.1 – An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018“. Accessed January 12, 2022.
  3. IRS.Gov. “About Form 2553, Election by a Small Business Corporation“. Accessed January 22, 2022.
  4. IRS.Gov. “Instruction for Form 2553“. Accessed January 12, 2022.